Risk assets continued to grind higher

Market index returns

Week to date since August 14, 2024 as of August 21, 2024

Index definitions: Global Real Estate = FTSE EPRA/NAREIT Developed Index; Global Infrastructure = Dow Jones Brookfield Global Infrastructure Index; Natural Resource Equities = S&P Global Natural Resources Index; Commodity Futures = Bloomberg Commodity Index; TIPS = Barclays US TIPS Index; Global Equities = MSCI World Index; Real Assets Index = 30% FTSE EPRA/NAREIT Developed Index, 30% Dow Jones Brookfield Global Infrastructure Index; 15% S&P Global Natural Resources Index; 15% Bloomberg Commodity Index, 10% Barclays TIPS Index. Source: Bloomberg, DWS. Past performance is not indicative of future results. It is not possible to invest directly in an index.

Market commentary:

Global equities continued their ascent, ending our review period just a hair shy of July’s all-time high. The lack of any meaningful bad news, renewed soft-landing expectations, and lighter summer trading volumes allowed markets to follow the path of least resistance, which has been higher. Minutes from the Federal Open Market Committee’s (FOMC’s) July meeting were released this week and showed some concern on employment trends, while the Bureau of Labor Statistics (BLS) revised payroll growth down by 818k jobs over the trailing twelve months, but neither of these events were enough to spoil the market’s mood. Rather, they reinforce investor expectations that the U.S. Federal Reserve (Fed) will cut rates in September and continue to do so at each subsequent meeting into spring or early summer of 2025. Equity market volatility (per the VIX index) remains subdued, falling below 15 during our review period, marking one of the fastest descents from a level above 50 (as was seen pre-market open on August 5), but ended our review period relatively unchanged around 16.3. Interest rates were also relatively tame this week, with the U.S. 10-year Treasury yield inching down 3.5 basis points (bps) to end our review at 3.80%, but far below the ~4.5% seen in early July.^[1]

Against this backdrop, all Real Assets classes saw positive returns this week, but all underperformed the broader equity market. Natural Resource equities gained the most with strong returns from the metals & mining names. Global Real Estate securities followed, while gains were slighter from Global Infrastructure securities and Commodities, and Treasury Inflation-Protected securities (TIPS) were again the relative laggards.^[2]

Why it matters: At some point the slowing employment growth and increased joblessness in the U.S. should raise concerns. On one hand, the Sahm Rule (named after Claudia Sahm), which states that whenever the 3-month average U.S. unemployment rises by 50 basis points (bps) or more from its 12-month low, a recession is underway, was triggered in July. On the other hand, a 4.3% unemployment rate doesn’t sound too bad in a historical context, as there will always be a level of frictional unemployment, and there is likely some wonkiness in the employment numbers leftover from the COVID-19 pandemic. Nonetheless, if job growth continues to slow and unemployment continues to rise, we expect economic growth will inevitably slow, which is probably not what the next president of the U.S. (whoever that may be) wants to deal with on day one. In any event, August’s nonfarm payroll data (to be released the first week of September) will be closely watched as a signal for the strength of the U.S. economy, the pace of anticipated Fed easing, and could have an outsized impact on the market’s direction.

Macro Dive: First, we’ll review the minutes from the last Fed meeting and what was said at Jackson Hole. Next, we’ll look at the most recent Purchasing Managers Index (PMI) data before turning to a wide look at the latest housing data in the U.S.

I’m going to Jackson: Minutes from the FOMC’s July meeting indicated progress towards the Fed’s 2% inflation goal and that expectations “…pointed to a first rate cut at the September FOMC meeting, at least one more cut later in the year, and further policy easing next year.” The minutes also noted solid economic growth so far this year, but at a slower pace than the latter half of 2023, that job gains were moderating, and while unemployment had increased, it still remained low. Following the release of the minutes, Fed speakers also appeared to reinforce the idea of a September rate cut but signaled the future easing path could be slow and meticulous. Fed Chairman Jerome Powell, in his Jackson Hole Economic Symposium speech, all but guaranteed a September rate cut, noting “We do not seek or welcome further cooling in the labor market conditions” and “the time has come,” but also was uncommitted on the timing and pace of future cuts. Should the Fed only cut twice this year for a total of 50 bps, it could be a disappointment for the capital markets as investors (via the Fed Funds futures market) are expecting at least 100 bps of rate cuts before the end of the year, implying at least one cut of 50 bps as only three FOMC meetings remain on the calendar.^[2]
PMIs feel like a repeat: That is, better than expected overall, held up by strength in service, but with manufacturing that can’t quite make it into second or third gear. The U.S. Composite PMI came in at 54.1 for August, better than expectations of 53.2 but a touch lighter than July’s 54.3. Manufacturing PMI at 48.0 was below expectations of 49.5 and contracted for the second month in a row after July’s 49.6. Meanwhile, Services PMI continued to surprise to the upside at 55.2, against expectation of 54.0, and expanded more rapidly than July’s 55.0. It was noted in the release that employment fell in August (and has been negative in 3 of the past 5 months) with a stall out in manufacturing hiring, while hiring in the services sector saw difficulties in finding workers. While the overall robust PMI data points to healthy GDP growth in the 3rd quarter, Chief Business Economist at S&P Global Market Intelligence stated, “This soft-landing scenario looks less convincing, however, when you scratch beneath the headline numbers.”^[3]
Housing market sends mixed messaging: As the housing market can have implications for a wide variety of Real Assets, such as apartments, self-storage, lumber, and regulated utilities, we thought it prudent to review the array of housing data that came out in the last week. First, the National Association of Home Builders (NAHB) Housing Market Index fell to 39 in July, the lowest read since 2023, indicating less optimism among homebuilders, with affordability and buyer hesitation affected by high prices and high interest rates giving cause for concern. Next housing starts and building permit data for July was released with both falling short of expectations, declining sequentially from June and lower than the year ago period. Permits for buildings of 5 or more units showed the steepest descent, falling 12.4% from the prior month and 18.2% from July 2023, which could be a positive indicator for existing apartment owners as this indicates new supply is expected to slow down. Mortgage applications for the week fell by over 10% from the prior week, as many of those looking to refinance did so in the prior two weeks as interest rates pulled back. Finally, existing home sales were mostly in line with expectations and grew slightly in July from June, while new home sales of 739k (seasonally annual adjusted rate) in July well exceeded expectations of 623k and grew over 10% from June’s level, which would seem to contradict some of the pessimism from the homebuilders, at least for now.^[4]

Real Assets, Real Insights: We’ll first look at how listed real estate securities and private real estate funds in the U.S. have been performing this year. Then, we’ll look at why the trains have stopped in Canada. Finally, we’ll review why oil prices have been pulling back.

A harbinger of things to come? (Real Estate): Second quarter private market real estate performance has been finalized hence we thought it worthwhile to review how U.S. listed real estate and private real estate have been relatively performing. Comparing the FTSE NAREIT Equity REITs Total Return Index for U.S. listed real estate and the NCREIF-ODCE Index (ODCE) for U.S. private real estate, listed real estate had a modest gain of 0.06%, while private real estate fell by 0.45% in 2Q (the most recently available data for private). The negative total return for private real estate (which consisted of 1.02% in income but a 1.46% decline in price) was the ODCE’s seventh consecutive quarter of negative total returns. On a year-to-date basis, U.S. listed real estate has fallen 0.13%, while private real estate has lost 2.81%, and on a trailing 12-month basis (ended 6/30/24) U.S. listed real estate has risen 7.79%, while private real estate has had a negative 9.25% total return. We have often stated that listed real estate markets can lead the private market by 9-to-12 months, indicating we should see private market values start to rise or at least flatten out, which we’re already seeing signs of. While we won’t get another read on our private market proxy until the fall, we can say that U.S. listed real estate, using the aforementioned index, has returned 9.65% from the end of the second quarter through August 21st.^[5]
Labor dispute “derails” trade (Infrastructure): In a situation that is evolving by the minute, first, the two largest freight rail operators in Canada shut down operations in anticipation of a strike or work stoppage this week by the Teamsters Canada Rail Conference union, which represents almost 10,000 rail workers. The management of both Canadian National Railway Company (TSX: CN) and Canadian Pacific Kansas City Limited (NYSE: CP) locked workers out in an effort to speed up resolution of ongoing labor disputes and ensure a “safe and structured shutdown.” Management hoped to resolve the issues before the fall, when rail shipments typically peak, and this is the first time in history that both rail operators have shut down at the same time. While hesitant to intervene at first, the Canadian government and the Minister of Labour mandated resumption of service and binding arbitration for both parties. While employees of Canadian National appeared head back to work on Friday, union members of Canadian Pacific refused to resume service and are questioning the constitutionality of the minister’s directive. Until service is fully resumed, this threatens to snarl trade across North America and strand commuters, which rely on rail in some of Canada’s largest cities. At the time of this writing, the lockout only affects rail lines in Canada and those that cross the U.S.-Canadian border. Operation solely in the U.S. and in Mexico appear to be still operating.^[6]
Oil prices take a slide (Commodities): Crude oil prices have been pulling back as of late, with the prompt WTI crude oil futures contract falling 5.2% during this review period and the Brent crude oil contract down 4.7%. Much of the recent weakness in crude oil can be attributed to a reduction in Middle East risk premiums, as the widely expected Iranian retaliatory attack against Israel has failed to materialize yet and may not even occur. Additionally, recent reports have highlighted major efforts to achieve an Israeli-Gaza ceasefire, and Israeli Prime Minister Benjamin Netanyahu is said to have accepted a "bridging proposal" from the U.S. government as a step toward finalizing a ceasefire deal in Gaza (although we’ll see if it sticks). In terms of supply, our own analysis continues to show an oversupplied market, with particular oversupply in the fourth quarter of this year, which likely will prevent OPEC+ members from rolling back their earlier voluntary cut commitments, while some members, such as Iraq, Kazakhstan, and Russia, continue to produce above their quotas. On the demand side, a broader-based global economic slowdown, emphasized by weaker Chinese data, could serve to further emphasize near-term further price declines.^[7]

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